Donald Trump was re-elected president in the November 2024 elections. He has since promised large, across-the-board tariffs that will go into effect on Day 1 via executive order. These promises mimic those he made during the campaign, but on a much larger scale. Whether these rates will become reality is an open question. Blanket rates would likely face legal challenges (interested readers can find a brief discussion on the legal issues of blanket rates here). For the sake of this post, I assume that the currently proposed rates (as of December 29, 2024) will go into effect unchanged. If that is indeed the case, then I have two major concerns: one economic and one political.
On the economic side, I worry that tariffs will significantly increase the prices of many goods. This is of course the point of protectionist tariffs, but many goods that America imports are intermediate goods. In other words, they are used in the production process. Final goods make up a relatively small portion of U.S. imports. Consequently, the tariffs will increase the cost of domestic production, reduce supply and lead to higher prices for all kinds of goods and services. High-tech production is likely to be hit hard here. Computer chips are largely imported; With few available options, high-tech manufacturers will bear the brunt of price increases, which will in turn reduce their comparative advantage.
Construction will also be hit hard. About a third of U.S. building materials are imported, including key components needed to produce structures, such as steel. At a time when construction and housing costs are already rising thanks to NIMBY, occupational licensing, and pre-existing rates, imposing more rates will only make housing more expensive. Furthermore, increasing the cost of constructing industrial buildings will frustrate any attempts to ‘reshore’ production.
A final area of economic importance is financing costs. The US has a large trade deficit, which means foreigners want to to invest in the US economy (another reason is that the US dollar is the international reserve currency). As a result, many of the dollars we send abroad when we buy imports come back as loan funds or other investments. By increasing the supply of borrowable funds in the U.S. economy, interest rates are lower than they would otherwise be, lowering the cost of investing. If tariffs were to substantially reduce imports, this would in turn reduce both exports and loanable funds coming into the US. A reduction in the supply of loanable funds necessarily means higher interest rates and, all else being equal, higher borrowing costs. Indeed, we saw these effects of the tariffs during Trump’s first term.
(An argument has recently emerged that tariffs do not actually increase prices, but rather decrease them by creating more competition in the domestic market. I will respond to that argument in a future blog post)
On the political side, some justify tariffs (or the threat thereof) as a bargaining tool. Unfortunately, the president-elect’s statements have undermined his negotiating power. Trump proposed imposing special tariffs on Canada and Mexico over illegal drugs and immigrants entering the US. This proposal likely destroyed any negotiating power Trump might have had because it made him lack credibility and unreliability. During his first administration, Trump renegotiated the North American Free Trade Agreement (NAFTA) with Mexico and Canada. The new agreement, the U.S.-Mexico-Canada Agreement (USMCA), addressed these and other issues. The purpose of this new treaty was to prevent such arbitrary cycles of tariffs and retaliation.
Unfortunately, by indicating that he supports new, arbitrary tariffs, Trump has indicated in no uncertain terms that the treaty is not worth the paper it is written on. In game theory terms, Trump has defected and now the rational behavior of the other parties will also defect. They will gain nothing from negotiations because any agreement would be worthless. Since the Mexican president has indicated that in response to tariffs she would also defect rather than negotiatewe see that Trump’s negotiating position has already been weakened.
(Aside: Using tariffs as a bargaining tool only works under very specific circumstances, which currently do not exist for the US. But that too is a matter for another blog post)
Like I said at the beginning, these are just concerns I have. How things actually look will matter. Some of what I’ve written here may not matter at all. I guess we’ll just have to see.